This article is taken from our FREE daily investment email Money Morning.
Every day, MoneyWeek's executive editor John Stepek and guest contributors explain how current economic and political developments are affecting the markets and your wealth, and give you pointers on how you can profit.
Pretty much since the start of this year, if not a bit before, the global economy has been beset by fears of imminent recession.
As a result, central banks have changed their minds about raising interest rates.
In turn, equity markets have rallied strongly in the last three months or so.
And now – just possibly – it might turn out that it was all another false alarm.
The yield curve does a backflip
The dreaded “yield curve” inversion occupied acres of financial headline space last week. I explained what a yield curve was and why it mattered if it turned upside down last week in Money Morning.
But in a (long) sentence, for those who can’t be bothered clicking through to that article: when the yield curve inverts, it means people think that interest rates will be lower in the future than they are now, which implies that a recession is coming (because that’s typically the reason for rates falling).
People worry about the yield curve flipping because it’s a pretty reliable indicator of recession. Trouble is, there are lots of different parts of the yield curve, and they all mean slightly different things. Also, one day’s inversion does not a recession make – the inversion has to persist for a little bit to be valid.
Which brings us to yesterday’s confidence-boosting start to the week. As John Authers points out on Bloomberg, we were treated to a series of PMIs.
A PMI is a Purchasing Managers’ Index. It gives us an idea of how the people who make decisions in a given business sector – services or manufacturing – are feeling about things. Long story short, a reading above 50 means the sector in question is expanding; below 50, and it’s shrinking.
So it gives you an advance reading of sentiment and activity in businesses across a given country. And, as you might imagine, if it’s below 50 for any great length of time, that’s a good sign that your economy is running into trouble.
The good news is that in the world’s two most important economies – China and the US – these decision makers, at least in the manufacturing sector, are feeling a bit perkier than they were last month.
And this is particularly important right now, because as you might have noticed, investors have been getting worried that we are heading for a recession.
Don’t get me wrong – China is still hardly looking amazing, but the PMI index at least rallied back into expansion levels for March, from a reading that indicated shrinking in February. And the US, was a lot stronger, with a reading of 55, driven mainly by rising new orders and rising hiring levels.
None of this means that the economy is all fine – it’s only one reading. But equally, we’ve not exactly been flooded with negative data either to justify the sudden flurry of recession fear. So as far as I’m concerned the jury is out. And the market feels the same – the yield curve un-inverted as a result of the data.
And given that the first quarter of the year, for several years now since the financial crisis, has been weirdly weak, I wouldn’t be surprised if this is just another duff first quarter rather than a systemic downturn.
Watch out for your own biases (and acknowledge them)
Admittedly, I have been sceptical about the idea of the world tilting into recession in the near future. My own investment thesis is that our next big crisis will be an inflationary one rather than a deflationary one (we’re always fighting the last war, so it makes sense to me that the next one will be different).
I still think this thesis is right, but as an intelligent consumer of my views, you should also recognise that however rational or independent-minded I believe I am, I am probably invested in a certain way of looking at the world, whether I like it or not. You should seek out views from equally smart (or smarter) people who think we’re looking at something different to an inflationary denouement.
(Don’t worry. As long as you keep reading my stuff as well, I’ll forgive you.)
To be clear, while this is all fun to talk about, none of this desperately matters for your investment plan. As I’ve said before, the economy and financial markets are two separate things. And in any case, your investment strategy should not be reliant on predicting the future, because that’s simply not possible.
You should be investing across a diverse range of cheap or reasonably-priced markets, using the most cost-efficient method you can find. How you split that between what I view as the five core asset classes – bonds, equities, cash, gold (and property, which is a subset of equity) – is mostly a function of your time horizon.
What I will say about the idea of a “surprise” non-recession is that it – combined with incredibly relaxed monetary policy around the globe – could well spur a much bigger recovery rally in stocks this year. And if it lasts for long enough, then we might start to see concerns about inflation making a comeback.
But we can talk about that when it happens. Meanwhile, stick with your plan.
By the way, if you haven’t yet bought your copy of The Sceptical Investor – my book on contrarian investing – you can still get a 25% discount if you’re a Money Morning reader. Snap it up here.